Vince Lucas_FINN 5303_ConocoPhillips Valuation Project

1

Vince Lucas FINN 5303 Valuation Project-COP

Part 1. Company Overview:

In the following paragraphs I will list specific information about ConocoPhillips. The premise

and source of my information is their SEC filing of their 10-K, Morningstar, Reuters, Stock-

Analysis-On.net, and Yahoo Finance.

Operations:

ConocoPhillips is headquartered in Houston, TX. The company was incorporated on November

16, 2001. ConocoPhillips is the world’s largest independent exploration and production

company, based on proved reserves and production of liquids and natural gas. It currently

employs approximately 19,100 people worldwide and operates in over 27 countries.

ConocoPhillips’s asset base reflects their legacy as a major company with a strategic target on

higher-margin projects. Their portfolio primarily includes North American shale and oil sands

assets; lower-risk legacy assets in North America, Europe, Asia and Australia, and several major

international projects. Their value proposition since 2012 to the shareholder was to deliver 3 to

5 percent production and 3 to 5 percent cash margin growth that are normalized for changes in

commodity prices, and pay a competitive dividend. This value proposition was predicated on

capital expenditures of approximately $16 billion annually.

ConocoPhillips has approximately 84% of its operations in stable countries that belong to the

Organization for Economic Cooperation and Development. This is a good indicator for stability

in foreign operations. The business segments are as follows: Alaska, Lower 48, Canada,

Europe, Asia Pacific and Middle East, and Other International. The segments are primarily

defined by geographic region. The percent of revenue generated by domestic versus

international was 19.72%, domestic operations and 80.28%, international operations. The Asia

Pacific and Middle East business segment generated the majority of their revenue with 51.80%.

ConocoPhillips has not been in the news specifically. However, the oil and gas industry has

been under intense pressure due to the downward trend of the price of a barrel of Brent crude.

Commodity prices are the most significant factor impacting the profitability and related

reinvestment of operating cash flows into their business. The industry has historically dealt

with this volatility in the past. ConocoPhillips’s first implementation was a reduction of capital

expenditures by 21% and after further evaluation reduced to 33%. Their strategy is to maintain

a strong balance sheet with a diverse and flexible portfolio of assets which will provide the

financial flexibility to withstand challenging business cycles in a volatile market. ConocoPhillips

is still projecting growth in regards to 2 to 3 percent for 2015.

ConocoPhillips released their 10K filing on February 24, 2015. The stock price on that day was

$67.09. Within one week their price had dropped to $64.78 and within two weeks the price

had reached a low for the year, which was a price of $60.87. According to a holding period

return, it was a reduction of 9.27% in ten days of trading. Today, their stock has rebounded for

the year and been in an upward trend since March 3, 2015. As of three days ago,

2


ConocoPhillips had been within 0.69% of its year-to-date max share price of 69.88. The market

is realizing ConocoPhillips has positioned itself well within the volatile market structure.

Finances:

ConocoPhillips met their short- and long-term liquidity requirements with a variety of funding

sources. Cash generated from continuing operating activities was the primary source of

funding. In addition, during 2014 they received $1,603 million in proceeds from asset sales and

issued $2,994 million of new low-interest notes. The primary uses of their available cash were

$17,085 million to support their ongoing capital expenditures and investments; $3,525 million

to pay dividends on our common stock; and $2,014 million to repay debt. During 2014 cash and

cash equivalents decreased by $1,184 million, to $5,062 million. Also, in addition to cash flows

from continuing operating activities and proceeds from asset sales, ConocoPhillips relies on

their commercial paper and credit facility programs and their shelf registration statement to

support their short- and long-term liquidity requirements.

ConocoPhillips issues a constant dividend. In their last fiscal year, ConocoPhillips issued $2.84

in dividends with a payout ratio of 61.7%. The dividend has sustained constant growth over a

ten year period. As of 2005, the dividend was $1.18; using the last reported dividend, it would

be an appreciation of 140.68%. ConocoPhillips financial leverage ratio is 2.25 and has an

interest coverage ratio of 15.49. The long-term debt is rated “A1” by Moody’s Investors Service

and “A” by both Standard and Poor’s Rating Service and Fitch. ConocoPhillips beta was

calculated at a 1.06. I used returns from the previous 5 years. I set two axis variables: The first,

being the independent variable, which consisted of the market return minus risk-free rate and

the second a dependent variable consisting of ConocoPhillips return minus risk-free rate. I ran

a simple regression with the two variables.

Part 2. Discounted Cash Flow Valuation (Intrinsic Value):

(a) Growth rate of earnings:

From the Morningstar® website I gathered pertinent data for the calculation of the growth

rate. I initially calculated historic growth rates in regards to both Geometric and Arithmetic

average. I went back historically ten years. I calculated both averages and returned a negative

value. My intuition leads me to believe the 2008 data skewed the Arithmetic average. I

reconfigured the formula for % change in EPS in the negative earning period. The

reconfiguration was the use of the absolute value in the denominator. After managing the

negative earnings, I still returned a negative growth value for my Arithmetic average. Logically,

my next step was to focus on last five years. Again, I returned values for both Geometric and

Arithmetic averages that were negative. Lastly, I ran a time-series regression for the last ten

years. I set my dependent variable as the EPS and set my independent as a chronological time

series. My R-squared value could not explain much variability, but I took my coefficient and

3


divided by the average of the EPS in the period. I calculated from the regression analysis a 1.1%

growth. I figured it to be a very conservative approach on approximating growth. My only

concerns were the R-squared value and p-value. Common sense intervened, it wasn’t as if I

was projecting 25% growth; again, it was a very conservative number. My Proof of work

follows.

(b) Cost of equity:

Utilizing the CAPM model, my cost of Equity is 6.75%. I used a market risk premium of 5%, risk-

free rate of 1.5%, and a calculated beta of 1.06. Again, as stated in the finance section of the

company overview in part 1, I ran a regression analysis over historical data from 5 years ago.

My proof of work follows.

ConocoPhillips EPS, 2005-2014

Year Data Point EPS % change in EPS

2005 1 9.55

2006 2 9.66 1.15%

2007 3 7.22 -25.26%

2008 4 -11.16 -254.57%

2009 5 3.24 129.03%

2010 6 7.62 135.19%

2011 7 8.97 17.72%

2012 8 6.72 -25.08%

2013 9 7.38 9.82%

2014 10 5.51 -25.34%

Averages: 5 year 10 year

Arithmetic: -5.72% -4.15%

Geometric: -7.79% -5.93%

Regression: 1.10%

SUMMARY OUTPUT

Regression Statistics

Multiple R 0.0297

R Square 0.0009

Adjusted R Square -0.1240

Standard Error 6.5248

Observations 10

ANOVA

df SS MS F Significance F

Regression 1 0.300 0.300 0.007 0.935

Residual 8 340.579 42.572

Total 9 340.879

Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%

Intercept 5.139 4.457 1.153 0.282 -5.139 15.418 -5.139 15.418

Data Point 0.060 0.718 0.084 0.935 -1.596 1.717 -1.596 1.717

4


The “bottom up” beta was the next logical step. I had an advantage with all peers operating

the same business segment or really only one business segment, the petroleum exploration and

production industry. I could have disaggregated into US versus international. It would have

been illogical due to all companies were in similar international markets that were stable. Also,

the proportions of domestic versus international were close. I felt comfortable with the

analysis as each company was very similar in structure and segments. I weighted each

ConocoPhillips, monthly rates of returnR(COP, t) R(S&P 500, t) T-Bill Rate r_i-r_f r_M-r_f

-20.43% -10.99% 0.22% -20.6500% -11.2100% SUMMARY OUTPUT

4.85% 8.54% 0.10% 4.7537% 8.4437%

4.70% 9.39% 0.09% 4.6052% 9.2952% Regression Statistics

12.95% 5.31% 0.14% 12.8100% 5.1700% Multiple R 0.697

-8.25% 0.02% 0.10% -8.3500% -0.0800% R Square 0.485

5.04% 7.41% 0.15% 4.8900% 7.2600% Adjusted R Square 0.476

3.02% 3.36% 0.12% 2.9000% 3.2400% Standard Error 0.049

0.29% 3.57% 0.06% 0.2300% 3.5100% Observations 59

12.22% -1.98% 0.04% 12.1800% -2.0200%

3.17% 5.74% 0.05% 3.1200% 5.6900% ANOVA

-1.35% 1.78% 0.03% -1.3800% 1.7500% df SS MS F Significance F

-6.01% -3.70% 0.02% -6.0300% -3.7200% Regression 1 0.127 0.127 53.759 0.000

1.04% 2.85% 0.06% 0.9800% 2.7900% Residual 57 0.134 0.002

6.60% 5.88% 0.11% 6.4900% 5.7700% Total 58 0.261

15.67% 1.48% 0.15% 15.5200% 1.3300%

-11.45% -8.20% 0.15% -11.6000% -8.3500% Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%

-5.34% -5.39% 0.08% -5.4200% -5.4700% Intercept 0.002 0.007 0.269 0.789 -0.011 0.015 -0.011 0.015

13.61% 6.88% 0.16% 13.4500% 6.7200% r_M-r_f 1.056 0.144 7.332 0.000 0.768 1.344 0.768 1.344

-5.05% -4.74% 0.15% -5.2000% -4.8900%

9.54% 8.76% 0.12% 9.4200% 8.6400%

4.37% 3.69% 0.14% 4.2300% 3.5500%

1.31% -0.23% 0.13% 1.1800% -0.3600%

13.18% 6.53% 0.08% 13.1000% 6.4500%

4.93% 2.26% 0.14% 4.7900% 2.1200%

9.89% 3.20% 0.11% 9.7800% 3.0900%

2.56% -0.10% 0.07% 2.4900% -0.1700%

-1.21% 2.85% 0.03% -1.2400% 2.8200%

-6.35% -1.35% 0.02% -6.3700% -1.3700%

2.69% -1.83% 0.02% 2.6700% -1.8500%

-3.38% -2.15% 0.04% -3.4200% -2.1900%

-5.45% -5.68% 0.01% -5.4600% -5.6900%

-6.98% -7.18% 0.00% -6.9840% -7.1840%

11.04% 10.77% 0.01% 11.0300% 10.7600%

2.40% -0.51% 0.01% 2.3900% -0.5200%

2.17% 0.85% 0.00% 2.1690% 0.8490%

-6.39% 4.36% 0.03% -6.4245% 4.3255%

13.19% 4.06% 0.09% 13.0980% 3.9680%

-0.71% 3.13% 0.08% -0.7941% 3.0459%

-5.76% -0.75% 0.08% -5.8432% -0.8332%

-2.49% -6.27% 0.09% -2.5795% -6.3595%

7.13% 3.96% 0.09% 7.0386% 3.8686%

-1.40% 1.26% 0.10% -1.4971% 1.1629%

4.32% 1.98% 0.10% 4.2174% 1.8774%

0.69% 2.42% 0.10% 0.5857% 2.3157%

2.33% -1.98% 0.10% 2.2252% -2.0848%

-1.57% 0.28% 0.09% -1.6635% 0.1865%

1.84% 0.71% 0.07% 1.7695% 0.6395%

0.02% 5.04% 0.05% -0.0314% 4.9886%

1.05% 1.11% 0.08% 0.9750% 1.0350%

3.71% 3.60% 0.08% 3.6314% 3.5214%

0.58% 1.81% 0.05% 0.5309% 1.7609%

2.56% 2.08% 0.02% 2.5395% 2.0595%

-1.37% -1.50% 0.03% -1.4045% -1.5345%

8.35% 4.95% 0.02% 8.3286% 4.9286%

2.22% -3.13% 0.04% 2.1832% -3.1668%

4.84% 2.97% 0.02% 4.8225% 2.9525%

6.49% 4.46% 0.11% 6.3795% 4.3495%

-0.72% 2.80% 0.05% -0.7658% 2.7542%

-2.95% 2.36% 0.02% -2.9671% 2.3429%

5


unlevered beta by market capitalization percentage of total market capitalization among the

five peers. Utilizing the levered “Bottom-up” beta increased my initial beta from a 1.07 to 1.18

and my Cost of equity to 6.75% to 7.39%. It added a more conservative approach to the

valuation of my cost of equity. I gathered “peer” data from Reuter’s. Reuters is a creditable

source and gave an explanation of their betas, which was pertinent to me. Reuter’s betas

are calculated based on trailing 5-year prices, on a monthly basis, relative to the S&P 500. My

proof of work follows.

(c) Dividend discount Model

I utilized my DDM model with metrics I calculated in my valuation to this point. My growth rate

was low at 1.1%. I used my intuition and decided to raise the growth rate 1.5% above the risk-

free rate. It seemed like a logical or common sense approach. I used the cost of equity that was

levered up with my “bottom-up” beta. I gathered the dividend from the previous year. I

calculated a current share price of $68.51. I felt the value to fair and conservative. My current

value has ConocoPhillips as slightly overvalued.

I researched and added a different model with a more aggressive approach. It was from a

creditable website showing all proof of work. I wanted to ensure I understood where the data

originated. The website took an aggressive approach at valuing the cost of equity and growth

rate. Their cost of equity was calculated with a 2.62% risk-free rate and a return on the market

of 13.88%. When calculated, they returned a value of 14.48% for their cost of equity. Their

growth expectations were a little lofty. They used a two stage model with a trending down

growth rate starting at 13.72% or comparable to their expected return of the market followed

by a terminal value of 9.87%.

Firm Beta Debt/Equity Ratio Tax Rate Unlevered Beta Market Cap Weight

Exxon Mobile(XOM) 0.9 0.167 0.3489 0.81 422.1 48.83%

Chevron(CVX) 1.15 0.1794 0.3811 1.04 227 26.26%

ConocoPhillips(COP) 1.07 0.4347 0.3816 0.84 86.4 10.00%

Occidental Petro(OXY) 1.43 0.1956 0.4482 1.29 75.3 8.71%

EOG Resources(EOG) 1.22 0.3337 0.4164 1.02 53.6 6.20%

Unlevered Average 1.0004 Weighted Average = 0.93

COP Levered "Bottom -Up" Beta 1.18

COP Cost of Equity w/"Bottom-Up" beta 7.39

*Information Gathered on Reuters 4/19/15

6


I felt my approach may have been too conservative where theirs may have been a little

aggressive. I believe with high confidence one could place a value in between the two models

and be correct. My school of thought on investing valuation is a conservative approach. It is

better to error on the side of caution versus being overly aggressive with a valuation. I would

defend my valuation by elaborating on current market structure of their industry. Their

production frontier has recessed recently, due to commodity prices. My proof of work follows.

(d) Free cash flow to equity discount models:

Defining the free cash flow to equity was calculated by a creditable website that identified the

work performed. After the determination of the previous year FCFE, I started the arduous task

of sifting through the financial statements to gather pertinent information to utilize a model in

our text located on page 359, Constant Growth FCFE Model. The first obstacle was to calculate

the Equity Reinvestment Rate. The equity reinvestment rate is meant to capture the amount

of capital the firm is using to generate future growth. I identified and calculated data from the

all three financial statements. I returned a value of 1.36 for their reinvestment rate. Next, I

calculated an expected return on investment with my reinvestment rate, which returned a

value of 15.05%. Next, I calculated the non-cash ROE. The non-cash ROE removes all excess

cash. The non-cash ROE should measure the return on noncash investments. I returned a

figure of 5.89% for non-cash ROE. Lastly, I took both values and placed in my constant growth

FCFE model. The model returned a value of 48.06 per share. My proof of work as follows.

COP Dividend Discount Model

Dividend 2.92

Growth Rate 3%

Cost of Equity 7.39%

DDM 68.51$

Forecasted COP Dividend Discount Model Discount Rate = 14.48

Last Year DPS01 2.84

1 DPS1 3.23 = 2.84 × (1 + 13.72%) 2.82

2 DPS2 3.64 = 3.23 × (1 + 12.75%) 2.78

3 DPS3 4.07 = 3.64 × (1 + 11.79%) 2.71

4 DPS4 4.51 = 4.07 × (1 + 10.83%) 2.63

5 DPS5 4.96 = 4.51 × (1 + 9.87%) 2.52

5 Terminal value (TV5) 118.15 = 4.96 × (1 + 9.87%) ÷ (14.48% – 9.87%) 60.09

Intrinsic value = $73.55

Current share price $67.69

Source: www.stock-analysis-on.net

Copyright © 2015 Stock Analysis on Net

7


Part 3. Relative Valuation:

(a) Find the peer firms:

For my peer firm or “pure plays” as I like to call them was simple. I chose the five largest oil and

gas companies in the United States by market capitalization. ConocoPhillips was 3rd of the five.

Being ranked 3rd among 5 mitigates the opportunity for noise in my relative valuation.

Intuitively, I have two firms larger than ConocoPhillips and two firms smaller than

ConocoPhillips. This anomaly should predispose my valuation as being accurate when

compared to its peers. All firms exhibit similar characteristics and operate both domestic and

ConocoPhillips, FCFE calculation

USD $ in millions

12 months ended Dec 31, 2014 Dec 31, 2013 Dec 31, 2012

Net income attributable to ConocoPhillips 6,869 9,156 8,428

Net income attributable to noncontrolling interests 69 59 70

Net noncash charges 10,159 6,538 6,199

Working capital adjustments -505 48 -1,239

Net cash provided by operating activities 16,592 15,801 13,458

Capital expenditures and investments -17,085 -15,537 -14,172

Proceeds from asset dispositions 1,603 10,220 2,132

Issuance of debt 2,994 – 1,996

Repayment of debt -2,014 -946 -2,565

Free cash flow to equity (FCFE) 2,090 9,538 849

Source: www.stock-analysis-on.net

Copyright © 2015 Stock Analysis on Net

ConocoPhillips FCFE

Equity reinvestment rate: 1.36

Capital Expenditures 17085

Change in noncash working Capital -505

Debt Ratio 0.4347

Net Income 6869

ROE 11.03%

Expected Growth in Net Income 15.05%

Noncash ROE: 5.89%

Net Income 6869

After Tax income from cash and marketable Securities: 3130

Book value of equity: 68562

Cash and Marketable securities 5062

Expected Growth in FCFE next year: 8.03%

Expected FCFE next year: 2257.90

Cost of Equity of firm: 6.80%

Growth Rate: 3.00% Current

Value: 59418 Market Cap = 84,400

Shares Outstanding 1236.32

Share Price 48.06

8


international business segments with similar interests. All firms are subject to volatile market

conditions that correlate with commodity prices. The only “noise,” which was mitigated as an

outlier in certain data was Occidental Petroleum (OXY) which returned only $0.79 per share for

their last fiscal.

(b) Earnings-based Multiple

Initially I took the formula for basically what it is Stock Price/Earnings per share. I observed a

value for COP’s P/E multiple at 14.88 from the previous day’s trading activity that was provided

by “Reuters.” When ConocoPhillips was compared to its peers from the same website, it had

the highest PE multiple. This lead to a good question; is ConocoPhillips overvalued in regards to

a PE multiple? I needed a little more analysis to determine if overvalued. My next step was to

calculate a forward PE multiple for all firms. The calculation gave me valuable data on

ConocoPhillips verses it peers. My formula used a combination of metrics such as Payout ratio,

Cost of Equity, ROE, and growth. I believe a PE multiple to be more of an art than a science.

Four of the five firms did not have a trailing twelve month growth rate. The economic factors

affected all firms in this sector severely in the last quarter. I used a growth rate of 3%. All firms

were established in their industry and none were classified as high growth. ConocoPhillips’s

personal projection was 3%. I know meeting market expectations is pivotal to the success of

the firm. Besides, it wasn’t that lofty of an expectation. ConocoPhillips forward PE multiple

was calculated at 14.05 with their peer average of 8.09. I am excluding Occidental Petroleum

due to the fact of an elevated PE ratio for low Earning per share in the previous year. Next, I

calculated the PE multiple with disaggregated metrics. I did want the basic formula of share

price divided earning. I wanted the drivers of the multiple which are growth and risk. I

calculated with the payout ratio multiplied by (1+growth rate) divided by cost of equity minus

the growth rate. I returned a value of 14.48. It was very similar to what was observed by

“Reuters.” My proof of work follows.

Company Payout Ratio Cost of Equity ROE Growth Forward P/E "Reuters" Reported

ConocoPhillips(COP) 61.70% 7.39% 13.21% 3.00% 14.05 14.89

Exxon Mobile(XOM) 35.60% 6% 18.67% 3.13% 12.40 11.50

Chevron(CVX) 41.50% 7.25% 12.65% 3.00% 9.76 10.88

Occidental Petro(OXY) 364.56% 8.65% 1.58% 3.00% 64.52 N/A

EOG Resources(EOG) 9.60% 7.60% 17.60% 3.00% 2.09 18.40

Average of Peers w/o "OXY" 8.09

ConocoPhillips(COP) PE:

Payout Ratio 61.70%


Growth 3.00%

PE 14.48

9


(c) Book value-based multiple:

On a personal note, I love this valuation model. If the “Oracle of Omaha”, has been successful

utilizing a strategy with this multiple for over 64 years, how can it not be given much attention?

The book value-based multiple in simplest forms is market capitalization divided by book value

of equity. It is easy to calculate for an “observed” value. My first step was calculated by

ConocoPhillips’s book value-based multiple with this simple formula. I returned a value of 1.63.

It was the same “observed” value “Reuters” returned. My next step was to disaggregate the

basic formula to find the primary drivers in the book value-based multiple, which is profitability

and safety. I gathered metrics such as payout ratio, cost of equity, ROE, and calculated growth,

which was determined by (1 – payout ratio) multiplied by ROE. I calculated the forward book

value-based multiples with the calculated growth rates from their last fiscal year. I compared

the forward book value-based multiple to the peer firms. Other than one firm, which was the

largest, ConocoPhillips had the highest PB multiple. ConocoPhillips forward PB was higher than

the average given from the peers. I calculated the PB multiple one last time by using the

formula payout ratio multiplied by ROE divided by cost of equity minus growth; I returned the

same value. ConocoPhillips’s had a theoretical book value-based multiple higher than the

observed, which is a good indication for an undervalued firm. My proof of work follows.

Part 4. Conclusion:

With a deeper understanding of ConocoPhillips, I feel it to be a sound investment on several

points. I will separate the points from the valuation techniques that brought me too this

conclusion. I reiterate the fact of only taking advice from professionals of whom had success in

their regarded field. Especially, when educated in a specific strategy that is based on sound

logic. I will place the quote to drive home the point. “It's far better to buy a wonderful

Company Payout Ratio Cost of Equity Calculated Growth ROE ROE-r Forward P/B "Reuters" Observed

ConocoPhillips(COP) 61.70% 7.39% 5.06% 13.21% 5.82% 3.50 1.63

Exxon Mobile(XOM) 35.60% 6% 3.13% 18.67% 12.67% 5.41 2.10

Chevron(CVX) 41.50% 7.25% 2.00% 12.65% 5.40% 2.03 1.34

Occidental Petro(OXY) 364.56% 8.65% 2.00% 1.58% -7.07% -0.06 1.77

EOG Resources(EOG) 9.60% 7.60% 2.00% 17.60% 10.00% 2.79 3.00

Average of peers w/o "OXY" 3.41

ConocoPhillips(COP) PB:

Payout Ratio 61.70%


Calculated Growth from Payout Ratio 5.06%

ROE 13.21%

PB 3.50

Observed Low and Theoretical High = Good Investment

10


company at a fair price than a fair company at a wonderful price” – Warren Buffet. I will list a

summarized table below.

Intuitively, I evaluated all aspects of the firm to infer my conclusion. The growth earnings were

contrary to calculate. The industry had been subjective to extreme volatility in the final quarter

of the physical year of 2014. ConocoPhillips as their peers I evaluated ended their fiscal year

on 12/31/14. All firms last quarter were impacted by the sharp drop in commodity prices.

Several of the firms including ConocoPhillips reported negative growth for their trailing twelve

months. All calculations I conducted other than regression analysis returned a negative growth

rate. In ConocoPhillips’s financial statements expected growth from 2 to 3 percent was

disclosed. I figured the risk free rate was 1.5%, so 3% should not be unattainable. Besides, a

good company will apply appropriate measures to mitigate the downward trend. I feel

ConocoPhillips 33% reduction in capital expenditures should help. Albeit, one does not want to

give the impression of an overly aggressive approach to reducing capital expenditures, it is the

foundation of growth.

The cost of equity and discount rates were calculated in my evaluation. I gathered additional

data from Dr. Damodaran’s website. He had listed the average cost of capital of 392 oil and gas

companies; the average was 9.45% with an average beta of 1.27. ConocoPhillips falls below

both averages with these metrics. ConocoPhillips’s manages a debt-to-equity ratio of 43% or

approximately 75% equity and 25% debt according to their WACC. The proportion of the risk of

the firm’s equity that can be attributed to business risk is 0.84/1.07 = 78.5%, while the

remainder is due to financial leverage risk. ConocoPhillips manages their debt well and is

reflected by their investment grade bond rating.

The dividend discount model retuned a value that was fair to current market price. I used a 3%

growth rate, however I did not just use a regression based beta or reported beta from a popular

website. I used the “bottom up” in my formula. I discerned to be a conservative approach that

returned a fair value.

The free cash flow to equity was a tedious task. In the last fiscal year ConocoPhillips price to

free cash flow to equity increase slightly in their fiscal year. The price per share is listed above.

The valuation was low compared to current market capitalization. I researched possible effects

Conoco Phillips Valuation:

Regression Analysis Growth Outlook 1.10%

Cost of Equity: 7.39%

WACC 6.06%

Dividend Discount Model $68.51

Free Cash Flow to Equity $45.70

Earning-based Multiples 14.48

Book value-based Multiple "Theoretical" 3.5

Risk Levered "Bottom-up" Beta 1.18

11


of a low valuation from Dr. Damodaran’s website. A few plausible explanations are capital

expenditures are too high relative to depreciation and the beta is high for a stable firm. My

intuition leads me to believe ConocoPhillips capital expenditures are relatively high verses

depreciation, $17,085/8329. Also, I am using a “bottom up” beta which is a higher beta than

the regression based beta.

The earnings based multiple of ConocoPhillips was the highest among their peers, with an

exception of the outlier. ConocoPhillips Earnings multiple being the highest were attributed to

relatively low risk among peers and an exceptional payout ratio. The payout ratio is great

indictor for the investor because of dividend being paid per earnings. All other indications of

the earnings multiple lead to fair or slightly over-valued.

The book value-based multiple is a valuation that I was taught by Dr. Sirmans at the U of A. I

was educated about a strategy that prolific investor Warren Buffet had initiated many years

ago. The strategy was evaluating “observed” PB ratios versus “theoretical” PB ratios. If I

returned a “theoretical” value that was higher than the “observed” value, the stock was

undervalued.

Lastly, ConocoPhillips has an “investment grade” bond rating. It is stable, low risk, and

profitable. ConocoPhillips is a “fair value” based on the DDM and more importantly, it is

undervalued by the book value-based multiple. ConocoPhillips pays an above average dividend

yield, over 4%. ConocoPhillips is a great company that can be purchased at a fair price.

Documents

Vince Lucas_FINN 5303_ConocoPhillips Valuation Project